POTBELLY SANDWICH WORKS Client Report DangerZone Consulting Anna Twum -­‐ Lead
Vijay Mohan
Jason Machado Professor Likens Senior Seminar Table of Contents Executive Summary………………………………………………………………………..…2
Company History………………………………………………………………………..……4
Financial Analysis………………………………………………………………………..…...7
Competitive Analysis………………………………………………………………………...11
S.W.O.T Analysis…………………………………………………………...……………........ …16
Strategic Recommendations………………………………………………………...……….24
1 Executive Summary DangerZone sees Potbelly Sandwich Works as a promising fast casual sandwich restaurant that
rightly boasts of a great brand focused on healthy food options for hip and trendy consumers.
With close to 300 stores it is at a critical stage of shaping its long-term strategy and has all the
ingredients to become and industry leader provided that Potbelly strategically positions itself to
operate at the cusp of the exciting and fast growing fast casual industry.
Potbelly is very focused on preserving its brand and this has been evident in its very calculated
growth trajectory in the early 2000’s. Currently, it possesses a strong management team, menu
and business model that has the potential of taking Potbelly to the next level domestically and
internationally. However, its most recent quarter has shed doubts on Potbelly’s potential and
many think they are treading on thin ice.
Very slow expansion, a decrease in number of entrees ordered from 2012 to 2013 and a harsh
winter have made Potbelly’s situation a little bit bitter for the markets to swallow. These
shortcomings have the potential to lead to even bigger problems for the company in the near
future.
DangerZone’s focus for Potbelly is to establish a very concrete and well thought out growth
strategy that does not simply focus on growing the number of stores but focuses on harnessing
existing geographical experiences and strengths in Midwest and Northeast to strategically
identify and enter new markets. With this in mind, we propose a possible expansion to the fast
casual market in Florida. We believe this move presents a strong market for Potbelly as well as
geographical diversification away from winter prone areas.
In the absence of a well-defined international strategy, we advise Potbelly to slow down
international expansion and increase attention and resources to solidifying Middle Eastern
operations. A strong foothold in the Middle East would position Potbelly to take advantage of its
fast casual market and establish a stronghold for further expansion. A potential market to look at
in the next 3 to 5 years would be Latin America.
2 Additionally, DangerZone recommends strengthening Potbelly’s franchising programming to
serve Potbelly’s overall franchise driven growth strategy. Cutting high development costs and
providing stronger financial support by partnering with a reliable franchise financer would
protect franchise investments in the long run. In terms of franchising structure, we recommend
that Potbelly add multi unit franchise options to its offering to take advantage of successful
single unit franchisors and cut down on franchise search costs.
To address Potbelly’s decreasing entree sales, DangerZone is pleased to present to our client,
Potbelly Gold, a unique rewards program that stays true to the values of Potbelly and leverages
the company’s technology and social media platforms for enhanced customer engagement. Our
recommendation comes based on the economics of rewards programs: behavioral studies have
shown significantly large and positive effects of incentive programs for general purchases. With
Potbelly’s commitment to community engagement, we take the rewards program model a step
further and propose a program feature that would give customers the chance to earn and donate
rewards to local charities. This completes a growth strategy that we believe stays true to the
Potbelly’s commitment to quality service and company goal of “making people really happy.”
3 Company History
Founded in 1977 by Peter Hastings, Potbelly Sandwich Works is one of the nation’s fastest
growing food service companies with a recently established international presence in the United
Arab Emirates. It occupies a market space known as fast casual- a blend between the traditional
fast food model and the full table service restaurant model. Potbelly is known for its commitment
to creating a warm, quirky and friendly ambience while providing fresh and fast sandwich
options. The stores, unique with their own distinct personality, are inspired by the neighborhoods
they are built in. Throughout the years, Potbelly has gradually expanded to over 297 stores1.
While a few shops are franchises, the vast majority is company owned with a strong and
continued commitment to establishing itself as a premier fast casual restaurant option for
customers.
The original store is located in Chicago, in a retail space that was previously an antique store
called Hindsight, owned by the Hastings 2. In an attempt to attract more customers to their shop,
they decided to start serving lunch. Their sandwiches quickly developed a cult following and
eventually became their main business model complete with toasty sandwiches, homemade
desserts and the occasional live music. In 1996, Bryant Keil, an entrepreneur, purchased the
original store and embarked on an expansion campaign with a strong dedication to preserving the
uniqueness of each shop in an attempt to keep the brand from solely becoming a fast food chain.
Potbelly went national in the early part of the 21ST century, after a huge capital investment of $11
million by private equity firms William Blair & Company, Waveland Investments, Oxford
Capital Partners, Inc. as well as the lesser-known venture capital firm, Maveron LLC under the
leadership of Howard Schultz and Dan Levitan, the men behind Starbucks Corporation. For their
investment, principals from each venture firm gained a seat on Potbelly's board of directors3.
1
Potbelly.com About Us Section
Potbelly.com History Section
3
“Potbelly Sandwich Works Inc. International Directory of Company Histories. 2007.
Encyclopedia.com. 3 February 2014.
2
4 By the end of 2001, there were eight Potbelly’s in the Chicago land area, with plans to take the
sandwich chain outside Illinois. Three leases had been secured in the Washington, D.C. area and
plans progressed for several Midwestern states as well. Revenues for Potbelly were steadily
growing, reaching a reported $15 million for the year.
Potbelly continued its expansion campaign in 2002 with 11 locations in and around Chicago,
each one bringing in as much as $1.3 million. By the following year, there were 30 Potbelly
restaurants in Illinois, Washington, D.C. as well as Michigan4. Sales were reportedly $40 million
for the year, due in part to strategic executive hiring and strong marketing campaigns.
By 2006, Potbelly had grown to more than 110 outlets and had estimated sales of $150 million.
While Potbelly could not compete with the size of Subway, which controlled a third of the
nationwide sandwich market, the small chain continued to grow by carving its own niche in the
food service industry. To keep its competitive edge and fund further expansion, a new round of
private financing was secured in the summer of 2006. This was amidst rumors of a pending IPO
offering.
On November 5th 2007, a new Potbelly store in Glen Ellyn, Illinois, became the first to feature a
drive-through. A second drive-through store was added shortly thereafter. In 2008, online
ordering was launched nationwide. In 2011, Potbelly opened two franchise stores in Dubai in the
United Arab Emirates; these are the first international Potbelly locations and were a step towards
establishing Potbelly as an international brand. In August 2013, Potbelly took the next step in its
expansion campaign and filed an IPO with US regulators to raise up to $75 million. Shares in the
company began trading on the NASDAQ Stock Market on October 4, 20135
Potbelly's menu has evolved over the years and currently features a variety of sandwiches that
are all served hot on regular or multigrain wheat bread. All sandwiches can be ordered "thin-cut"
4
5
Potbelly.com History Section
Yahoo Finance
5 style, in which one third of the bread is cut out. Potbelly began offering salads in February 2007.
The menu also includes soup, shakes, malts, smoothies, and cookies. Some locations offer
Starbucks coffee along with a breakfast menu6. Most restaurants feature live music from local
musicians during the lunch hours.
Potbelly goes to great lengths to make their shops special by procuring and creating little
touches, quirks and local artifacts that reflect the neighborhood of each shop. This is a direct
result of their commitment to not falling into the purely fast food category. In addition, Potbelly
incorporates live lunch performances by local musicians that support a non-profit in the area in
which the store is located. This localized corporate social responsibility is in stark contrast to
traditional corporate responsibility models especially within the restaurant industry.
6
Potbelly.com Menu Section
6 Financial Analysis From Potbelly Corporation’s initial public offering of common stock on October 7, 2013 to
the close of trading April 11, 2014, the value of its common stock has declined 44%. This
runs in sharp contrast to the shares of its main publicly traded competitors, Chipotle
Mexican Grill and Panera Bread, which have posted positive gains of 23.2% and 5.6%,
respectively. Potbelly has been outperformed by the index on which it trades, the
NASDAQ-GS, as well as the broader market-tracking S&P 500 index, which have posted
returns of 5.1% and 9.2% percent, respectively. A summary of the performance of a $100
investment made on October 7, 2013 in all of these companies or exchanges is included in
the graph below.
Figure 1:
Performance of Selected Investments
160.00
140.00
120.00
100.00
80.00
60.00
40.00
20.00
0.00
10/7/2013
11/7/2013
Potbelly
12/7/2013
Chipotle
1/7/2014
Panera
7 2/7/2014
NASDAQ-­‐‑GS
3/7/2014
S&P 500
4/7/2014
Clearly, Potbelly has failed to meet investors’ expectations since its IPO six months ago. It has
lagged behind both its competitors and the broader market as a whole. DangerZone believes that
the company’s failure to meet analysts’ expectations for earnings has been the main reason for its
tumbling stock price since its October IPO.
Recent quarter and annual reports show that Potbelly posted a net loss of $63.7 million for FY
2013, down from net profit of $13.5 million in FY 20127. However, it should be noted that
these numbers are affected by a number of one-time expenses and events. Immediately
following its IPO, Potbelly paid out a one-time $49.9 million cash dividend to its original
investors and repaid $14 million of an outstanding credit facility to JP Morgan Chase in addition
to investments made to support new shop growth. For fiscal 2013, Potbelly’s general and
administrative expenses as a percentage of total revenues were 9.7%, excluding the effect of any
one-time costs associated with our initial public offering The company has no plans to pay out
future dividends and no further loan repayments of such high value are likely to be paid in the
near future. Therefore we believe it is more informative to examine Potbelly’s net operating
income to get a clearer picture of the company’s financial performance.
Net operating income decreased to $1.48 million in 2013, down from $8.57 million in 2012.
Though total revenues increased, expense growth outpaced revenue growth by three percentage
points, contributing to an 82.8% decrease in annual net operating income. Reasons for the
decline are manifold, including extreme weather conditions during the winter of 2013-2014 that
inhibited revenue growth, increased rent costs resulting from Potbelly’s aggressive expansion
into high-cost areas such as Boston and New York City, and general administrative expenses
which spiked during 2013 because underwriting fees paid to investment banks. As of FYE 2013,
Potbelly operated twenty-two stores in New York and Boston, a sharp increase from the five it
operated as of FYE 2011. Without consistent revenue growth from sandwich sales in stores,
continued expansion into high-rent areas may not be a sustainable strategy.
7 Potbelly Annual 10K 8 Because Potbelly earns 99.6% of its revenues from stable company-owned sandwich shop sales
and only 0.4% from franchise royalties and fees, it places a high value on year-over-year sales
growth in company-owned stores that have been open for fifteen months or longer8. This metric,
called comparable store sales growth, increased by 1.5% in 2013 over its 2012 level. However,
price increases in menu items drove this increase, which offset a decrease in the number of
entrees ordered. Dangerzone strongly believes that it will be difficult to maintain revenue
growth solely through price increases in the highly competitive fast-casual food business, which
defines itself by providing high-quality food at affordable prices. In order to maintain
sustainable revenue growth, it will be necessary to increase the count of entrees ordered –
demand for Potbelly’s sandwiches must increase, not price. Though the exceptionally cold
winter of 2013-2014 played a role in declining revenues at Potbelly (especially because the
majority of the company’s stores are located in cold-weather areas in the United States), Potbelly
will need to maintain its price competitiveness with its larger competitors such as Chipotle
Mexican Grill and Panera Bread.
To better understand Potbelly’s place within the industry, we include an analysis of some key
financial metrics for two of Potbelly’s competitors. Subway and Jimmy John’s are not publicly
traded and so they are not included in this analysis.
Table 1
Chipotle
Solvency and Leverage Ratios
Panera
Potbelly
Debt/EBITDA
0.88
1.53
22.43*
Interest Coverage Ratio
NA
297.98
3.81
Debt/Equity
0.31
0.69
0.22
*For FY 2012, this ratio was 5.29, closer to its competitors, but still much higher.
Because Potbelly posted poor earnings, even before one-time expenses such as the $49.9 million
dividend payment is figured in, its Debt/EBITDA ratio, a measure of how long it would take for
a company’s operating income to finance its debt, is far higher than its competitors’. While
Chipotle does not have any interest expenses and Panera Bread generates enough income
8 Potbelly For 10K Annual Report Period ending 12/29/2013 9 annually to make almost 300 times necessary interest payments, Potbelly can only manage an
interest coverage ratio of 3.8 times.
Table 2
Profitability Ratios
Chipotle
Panera
Potbelly
Gross Margin
36.22%
35.34%
30.82%
Return on Equity
21.29%
28.03%
45.54%*
Return on Assets
16.30%
16.61%
41.62%**
* Even if we only use operating income for this metric, it is still 0.96%.
** Likewise, if operating income is used for this metric, it is still low, 0.68%
In addition, Potbelly posted very poor ROE and ROA numbers, lagging behind its larger and
more profitable competitors. However, the company’s core business of selling sandwiches
appears to be financially sound, as Potbelly posts a gross margin of 30.82%, not far behind its
competitors, which both stand at slightly over 35%. This suggests that Potbelly will need to cut
overhead costs in order to ensure that its final net income numbers are more in line with its gross
margin.
Table 3
Liquidity Ratios
Chipotle
Panera
Potbelly
Quick Ratio
3.28
0.93
4.25
Current Ratio
3.34
1.00
4.37
Fortunately, Potbelly appears to have no major issues with liquidity or leverage, boasting ratios
in these areas to its competitors, as it maintains a healthy asset base to protect against sudden
shocks. The company maintains a $35 million credit facility with JPMorgan Chase (expiring in
2017), which requires that it maintain a maximum leverage ratio of 2.25:1 and a minimum debt
service coverage ratio of 1.5:1. Potbelly currently meets both of these requirements easily, and
we believe that the financial gains to be had from maintaining favorable credit terms with the
large bank will provide further incentive for Potbelly to keep its finances in order.
10 FIVE FORCES ANALYSIS According to new research from The NPD Group, the fast-casual segment’s growth in traffic, for
the fifth consecutive year, far surpassed that of every other restaurant segment in the 12-month
period ended in November 2013. Total customer visits to fast-casual restaurants increased 8
percent for the 12 months ended last November, compared with flat traffic overall for all
restaurant segments. The fast-casual segment’s average check was $7.40 during that period, higher
than the $5.30 average for quick service but well below casual dining’s average of $13.66. Unit
expansion was the main driver of fast casual’s traffic and sales growth last year: for the 12 months
ended last November, the number of fast-casual chain locations in the United States rose by 903,
or 6 percent, to 16,215 total units and it is projected to increase in the next two years. We describe
the industry further using the Porter’s Five Force Analysis Model.
Figure 2
• Fair amount of buyer power because of many sandwich opQons and other types of fast food • Power is limited due to a large reliance on fast food. • High entry and capital costs, government regulaQons and licensing • Saturated market, brand name • Economies of scale • Small switching cost Entry (Low ) Buyer Power (Moderate ) Internal Rivalry High • Potbelly relies on a limited number of suppliers • Contract with DistribuQon Market Advantage (DMA) • Low switching cost, limiQng supplier power Supplier Power (Moderate) SubsQtutes (High) •  High propensity to subsQtute • Buyer switching costs are low 11 Under the Standard Industrial Classification system, fast casual restaurants fall into the category
of Eating Places, code 5812. This category is part of the larger industry category of
Accommodation and Food Services.
Entry
The threat of new entrants to the fast casual dining industry is low mostly due to the presence of
high barriers to entry. The fixed capital cost to initially build a store is high, and significant
government regulation surrounds food establishments and franchise licensing, further increasing
the barriers. Potbelly has cleared a major hurdle by establishing its current locations and
receiving the necessary licenses.
The fast casual dining market is already saturated with many companies with recognizable brand
names, making entrance even more difficult. Chains like Panera and Chipotle have reached
many areas of the country, and consumers already know what they will get at these restaurants.
Smaller, more regional restaurants also crowd the market, making it difficult to establish a new
fast casual restaurant.
Significant economies of scale benefit large chains and make it difficult for new entrants to
compete on price. Companies like Potbelly and Panera sell large quantities of food across
numerous locations, so they can buy supplies in bulk and reduce costs.
Fast casual restaurants tend to have a small switching cost. This cost is primarily determined by
restaurant proximity to the consumer, and with so many options packed tightly in most urban
areas, switching to a competitor is easy. This makes it easier for entry into the market, as
consumers can be convinced to switch from a current choice to a new entrant.
Overall, Potbelly needs to worry more about currently existing competition rather than possible
entry of new rivals. Successful chains of fast casual restaurants have well-known names and
products and enjoy economies of scale. Low switching cost makes entrance more enticing, but
Danger Zone believes that current competition is a much bigger threat.
12 Buyer Power
Buyers are given a good amount of negotiating power through the saturation of the sandwich and
fast casual restaurant markets. With so many dining options, Potbelly customers can easily
compare prices and switch to a competitor. This puts pressure on Potbelly to keep prices
reasonable and consistently deliver a product that meets customers’ expectations.
Buyer power is somewhat reduced by the convenience aspect of the fast-casual restaurant
industry. Most of Potbelly’s customers are workers who are often on a tight schedule and only
have a small amount of time to get lunch. Thus, customers’ price elasticity is reduced due to
what can be viewed as a convenience premium, as they do not have time or are not willing to
compare prices of different restaurants.
Supplier Power
Potbelly depends on consistent product supplies, as it must have the ingredients to make any
sandwich on the menu at all times. The low cost of customers switching to competitors makes
the unavailability of any menu item a good enough reason to choose another restaurant, which
puts some power in the hands of the suppliers.
A small number of suppliers currently provide Potbelly with the food and ingredients the
company needs, giving the suppliers a foothold for bargaining in the future. If Potbelly gets all of
its bread from one source, this supplier may be able to raise prices without losing the company’s
business; delivering a consistent product across locations is vital to Potbelly’s profitability, and
knowing this increases the power of the current suppliers.
Potbelly’s contract with Distribution Market Advantage (DMA), a cooperative of food
distributors spanning the nation, makes getting supplies easier but also increases supplier power.
The union of suppliers allows them to work together to increase their power, but certain parts of
Potbelly’s contract limits this power. Fixed prices protocols are included in the contract, which
prevents price increases during an agreed-upon timeframe. Thus, Potbelly’s ties with DMA
13 prevent the exploitation of suppliers but do not simply put all the power in the cooperative’s
hands.
Overall, supplier power is limited because Potbelly has a low switching cost. The abundance of
food distributors gives the company plenty of options, and if a current supplier has costs that are
deemed too high, Potbelly has little reason not to switch to another supplier. Potbelly’s focus on
high quality ingredients limits the number of acceptable suppliers, but supplier power in the
industry is still low. There is little to no risk of supplier power resulting in a significant cut in
Potbelly’s revenues.
Substitutes
Consumers in the fast casual industry have a high propensity to substitute due to factors relating
to location, food quality and price. Competitors and substitutes like local delis or “convenient
meals” in supermarket delis can take business from Potbelly if they build new convenient
locations or offer more enticing quality or prices, so it is vital that Potbelly strategically chooses
locations to operate and keeps costs and quality in line with what customers want and expect.
As this report previously mentioned, buyer-switching costs are low, and this serves as the driving
force for the high propensity to substitute. Potbelly could help reduce the threat of substitutes by
increasing this switching cost through a customer loyalty program.
Complements to Potbelly include beverages and food ingredients, as the costs of these determine
the profits the company can reach. These costs tend to be stable over time, so Potbelly does not
need to worry too much about changes in its complements.
Internal Rivalry
Potbelly competes with large, national chains, many of which have a much more expansive
reach. Subway has the most US locations of any restaurant with 23,336, while Panera has 1,736.
In Potbelly’s central location of Chicago, over 120 Jimmy John’s are in operation. Competition
is tough in Chicago with so many Jimmy John’s around, so expansion to new locations is
14 important, but Potbelly will be forced to compete with bigger chains like Subway and Panera in
most urban US locations.
Potbelly also competes within the larger market for fast food restaurants. While the company’s
focus on higher quality ingredients differentiates it from many of the other fast food restaurants,
many of the fast-food chains, including McDonalds are increasingly focusing on healthier and
higher quality food. In addition, many other fast food restaurant chains are looking to improve
the quality of their food and restaurant décor. At the same time, there has been a push in the fastcasual market towards keeping prices low and providing better value to consumers. These two
forces serve to bring Potbelly and other fast-casual restaurants in more direct competition with
the larger fast-food chains. In this larger industry, Potbelly is a much smaller player, with a
market cap about one tenth the size of the largest company in the industry, McDonalds
Corporation.
Expansion could be tough due to previously established customer loyalty to competitors. Thus,
Potbelly must distinguish itself from places like Panera in order to give customers an incentive to
try a new product. Switching costs are not an issue, so Potbelly only has to be able to overcome
previously established loyalty.
Fast food is responsible for 72.8% of whole food industry’s revenues9. Thus, Potbelly needs to
view fast food as a rivalry source, even if it is not a direct competitor. The market saturation that
exists makes it difficult for Potbelly to carve out a niche that will attract customers, so this
rivalry needs to be addressed by specific strategies.
9 http://group5wiki.wikidot.com/competitive
15 SWOT Analysis Strengths
Weaknesses
•
Experienced management team
•
Impressive community involvement
•
Great quality food
•
Lack of a customer loyalty program
•
Mobile apps
•
Slowing revenue growth
•
Market Niche
•
Distinctive ambience
Threats
•
Highly concentrated geographic
operations
Opportunities
•
Rising food costs
•
Attitudinal changes
•
Rising employee expenses
•
Expected growth in domestic and
•
Uncertain economy
international sandwich and fast casual
•
Fierce competition
industry.
Strengths
•
Experienced management team and leadership
Potbelly’s strength lies in its strong management team and board of directors. The wealth
of experience and strategic advice is expected to positively shape the long-term future of
the organization. Current CEO, Aylwin B. Lewis, was President and Chief Executive
Officer of Sears Holdings Corporation, a nationwide retailer, from 2005 to 2008. He also
had work experience with Yum! Brands. Potbelly’s board of directors and key investors
consists of veterans from the retail and restaurant industry that were successful in their
respective careers and are in full support of the company’s mission and values. Notable
among them is Starbucks Corporation Chairman Howard Schultz, whose private equity
firm Maveron has made a significant investment in Potbelly.
16 •
Community involvement
Over the years, Potbelly has developed an impressive community engagement program as
part of its business model. In line with their philosophy on giving and their overall
mission: “To Make People Happy” Potbelly has become an active part incommunities by
sponsoring community events and shake fundraisers where 25% of total revenue
generated during the event is donated to a cause. This has been vital in separating the
Potbelly brand from other fast food sandwich providers and creating a socially
responsible brand that appeals to its target audience. It puts Potbelly in a good position to
attract additional clients that are more socially conscious about their consumption
decisions and by providing spaces for events, leverages the support of local charities to
drive foot traffic into their stores. Implicit in this vision of positive impact are the
Potbelly Franchisees as well as its employees, making this a company wide commitment.
•
Phone app for ordering and information
Potbelly’s iPhone and Android App presents a good foundation for increasing customer
engagement via social media and technology by making the potbelly experience
convenient and seamless. With these Apps a customer can easily pull up the menu, place
and order, enter their credit card for payment, and find the closest restaurant location for
pick-up. Additionally, customers can sign up for informational newsletters and provide
feedback.
•
Quality of Food
Potbelly, as explained earlier, uses “fresh ingredients ” and takes pride in the food they
are giving to their customers. Accolades for good quality food includes first place
positions in the Sandwich category by Consumer Picks Survey and Trip Advisor
Certificate for Excellence award. To qualify for a Certificate of Excellence, businesses
must maintain an overall rating of four or higher, out of a possible five, as reviewed by
travelers on TripAdvisor, and must have been listed on TripAdvisor for at least 12
months. Additional criteria include the volume of reviews received within the last 12
months. In the Consumer Picks Survey published by Restaurant News, Potbelly beat its
17 competitors and topped the overall sandwich category. Assessment was based primarily
on the quality of the food and the overall customer experience. A quick look at customer
reviews on Yelp and Google Reviews, two popular reviews sites, shows very favorable
ratings for food quality. “ Great Sandwiches!” is a comment that runs through many
posts.
•
Market Niche
Current consumers tastes are now geared towards a blend of convenience and a more
inviting in-store experience over speed and convenience. Potbelly has put itself in a great
position to capitalize on this market especially in the Chicago area. With its thin and
vegan bread slices option Potbelly has established itself as a healthy alternative in the
sandwich industry as well.
•
Distinctive Ambiance
Potbelly is committed to creating an ambiance in their stores and a culture within
Potbelly that is warm, inviting, and embracing. They design each store to provide a
distinctive environment, in many cases using fixtures and materials that reflect
neighborhood locations as a way to engage customers. Potbelly staff are trained to the
highest standards of customer service and have the skills, expertise, and personalities to
make each visit a delight. Many of Potbelly stores incorporate the warmth of the iconic
potbelly stove and cozy seating areas, which makes it an ideal gathering spot for many
customers. Furthermore, Potbelly stores are designed to visually reinforce the distinctive
difference between what they have to offer and what their competitors provide.
Weaknesses
•
Highly concentrated geographic operations
Potbelly has highly concentrated geographic operations in the Greater Chicago area. This
concentration increases the risk of Potbelly’s operations and may put them at a
disadvantage to their other competitors that have more diversified locations. The United
States population is significantly concentrated along its coast, however Potbelly has not
taken full advantage of coastal markets and with competitors like Panera Bread pushing
18 the pedal of expansion on the West Coast, Potbelly might be missing out on some key
market share.
Furthermore, Potbelly's store footprint is heavily concentrated in a few cities. Chicago's
city limits contain more than 40 locations, while Washington, D.C. has more than 20.
This means that around 20% of the company's total locations are accounted for in two
cities. The last quarter of 2013 saw a government shutdown in Washington and an
exceptionally harsh winter in the Midwest. Potbelly ended up taking a very big hit to
revenues.
•
Lack of a customer loyalty program
Currently, Potbelly lacks a customer loyalty program because of unfounded fears that
discounting most often results in higher prices for customers which they claim they want
to avoid. The saturated nature of the fast casual market means that food chains like
Potbelly need to put its resources into customer retention and loyalty. Potbelly’s
competitors such as Panera have already established very successful customer loyalty
programs that they use to not only engage customers but also collect data that is vital to
their long-term strategy.
Potbelly is unfortunately missing out on these great advantages. Current technology has
made the costs of managing a customer loyalty program very affordable and if designed
properly can bring in enormous amounts of foot traffic and revenue. McDonalds having
realized the advantage is currently piloting its own customer loyalty program.
•
Limited breakfast menu and drive through options
The perception that Potbelly is a lunch-only establishment is another issue. A recent
study revealed that restaurant breakfast sales were estimated to have reached more than
$47 billion in 2013, while they are expected to rise another 5% in 2014. Even though
Potbelly serves breakfast, it doesn't have the menu variety or restaurant capability to
serve the meal as well as Panera Bread or McDonald's.Likewise, the lack of drive-thru's
at the majority of Potbelly locations puts the company at a disadvantage during the
morning hours when people are rushing to work. Fast food
19 breakfast options like McDonald's, Dunkin' Brands, and Burger King all have a leg up on
Potbelly in this time slot.
Opportunities
•
Changes in Attitude
Consumers especially within the United States are becoming increasingly health
conscious and aware of obesity and food responsibility. Even if the major fast-food
chains have responded by offering more healthy options on their menus, this trend has
hurt the Fast Food Restaurants industry, especially hamburger, meat products and fried
foods. The Sandwich industry, seen as a healthier alternative, has seen great growth in
recent years and is only expected to keep growing. Potbelly has established itself as a
player in this market and has the opportunity to capture a significant chunk of this
growing market because of its healthy and socially aware image.
•
Expected Growth in Sandwich and Fast Casual Industries
Fast-casual sales increased 13 percent in 2012, and the largest chains—those which each
made more than $325 million last year—did even better, growing by 16 percent. Fastcasual restaurants continue to outperform both quick-service and full-service
establishments and post strong gains even while the rest of the industry is having a more
difficult time10. Looking forward, the trend is expected to continue. Whereas the
compound annual growth rate for all limited-service restaurants is 4.5 percent (2012
through 2017), fast-casual operators are expected to grow 10 percent, on average, over
the same period.
Threats
•
Competition
Although Potbelly is a very specialized quick-service restaurant, Competition poses a
huge threat. Potbelly has both direct competitors that are similar themed chains in the
10 “Fast Casuals make Inroads” www.npd.com 20 market and indirect competitors that are other popular fast food and fast casual
restaurants. The restaurants that directly compete with Potbelly are Subway, Panera, and
Jimmy Johns. Subway is the leader in the Sandwich fast food category, according to a
Standard and Poors’ report on the Restaurant industry. Potbelly has a number of indirect
competitors: McDonalds, Starbucks, Yum! Brands, and Sodexho and may also compete
with companies outside the fast casual and quick service and casual dining segments of
the restaurant industry. For example, another source of competition could be deli sections,
in store cafes. Convenience stores and casual dining outlets that exist to serve the needs of
customers looking for higher quality food and present a more diverse menu in better
locations and at a significantly lower cost. Among other things these competitors might
benefit from, better facilities, better management, more effective marketing and more
efficient operations.
•
Economic Uncertainty
Revenues in the restaurant industry are highly correlated with the health of the economy.
Thus economic uncertainty poses a constant risk. In times of economic hardships,
disposable income is negatively affected and the response tends too be a decrease in
consumption. For restaurants this means that changes to tax and interest rates changes in
labor market growth and increasing gas prices leads to more subdued growth in
household incomes decreasing consumer expenditure on take-out food. More people
choose to eat home-cooked meals instead of going out to eat and when they do go out to
eat, average consumers are more likely to purchase lower-priced items. Potbelly faces a
particularly higher risk because they have a higher price point than restaurants like
McDonald’s that have value menus.
•
Real estate costs
Identifying and securing an adequate supply of suitable new sites presents significant
challenges because of the intense competition for those sites in target markets, and
increasing development and leasing costs. This may be especially true as Potbelly
continues to expand into more urban locations. Further, any continued restrictions of
credit markets may require developers to delay or be unable to finance new projects.
21 Delays or failures in opening new restaurants due to any of the reasons set forth above
could materially and adversely affect Potbelly’s growth strategy and their expected
results. Moreover, as they open and operate more stores their rate of expansion relative to
the size of stores will decline, which may in turn slow our sales and profitability growth.
•
Rising food costs
Food prices rose 0.4% in February, the most since September 201111. Droughts,
unusually cold winter weather, rising exports and a virus outbreak in the hog population
are among the causes of food inflation, which is expected to accelerate in 2014. The
United States Agriculture Department expects grocery store prices to increase as much as
3.5% in 2014, up from 0.9% last year. Among the foods most affected is beef. The
average retail cost of fresh beef last month was $5.28 a pound, up from $5.04 in January
and the highest on records dating to 1987.
Potbelly’s profitability depends in part on their ability to anticipate and react to changes
in food and supply costs. In the past, they have generally been able to recover inflationary
cost and commodity price increases for, among other things, fuel, proteins, dairy,
produce, wheat, tuna, and cream cheese through increased menu prices. There have been,
and there may be in the future, delays in implementing such menu price increases, and
economic factors and competitive pressures may limit their ability to fully recover such
cost increases12.
•
Rising employee expenses
Due to the Health Reform Act, Potbelly will have to offer health insurance coverage to
more of its employees. Currently they offer eligible full-time and part-time U.S.
employees the opportunity to enroll in healthcare coverage that they subsidize. Over the
years Potbelly has not had many eligible employees participate in their healthcare plans.
However, changes to the U.S. healthcare laws that become effective in 2014 have lead
some eligible employees who currently do not participate in their healthcare plans to
enroll for coverage. Such changes in the law include the imposition of a penalty on an
11 Bureau of Labor Statistics 12 Potbelly Annual 10K 22 individual who does not obtain healthcare coverage and provisions making certain
individuals who can obtain employer coverage ineligible for healthcare premium tax
subsidies that would otherwise be available in connection with the purchase of coverage
through an exchange. If a significant number of eligible employees who do not currently
participate in Potbelly’s healthcare plans, or who currently participate in their lower cost
limited coverage plan, choose to enroll, healthcare costs may increase significantly and
negatively impact Potbelly’s financial results
•
Poor initial performance of new restaurants
Historically, many of Potbelly’s new restaurants have opened with an initial ramp-up
period typically lasting 24 months or more, during which they generated sales and
income below expected levels. This is in part due to the time it takes to build a customer
base in a new area, higher fixed costs relating to increased labor and other start-up
inefficiencies that are typical of new restaurants, and a larger proportion of recent
openings being in higher rent sites than have been historically targeted. It may also be
difficult to attract a customer base if Potbelly is not able to staff restaurants with
employees who perform to high standards. New restaurant development activity has
broadened recently to incorporate trade areas or restaurant sites in which we have little or
no prior experience, including smaller or more economically mixed communities,
highway sites, outlet centers, and restaurants in airports and food courts. The risks
relating to building a customer base and managing development and operating costs may
be more significant in some or all of these types of trade areas or restaurant sites.
23 RECOMMENDATIONS Customer Loyalty Program
The highlight of Potbelly’s lack luster performance in the recent financial year has been its price
driven revenue growth, a trajectory that is not sustainable because of the decrease in the actual
number of entrees ordered at Potbelly. Further competition means that Potbelly would not only
have to turn its attention to increasing foot traffic into its existing stores but focus on customer
engagement as well. DangerZone recommends that Potbelly establish a customer loyalty program
to increase customer engagement. This recommendation is based on what we have determined to
be a strategy that is currently working very well for its competitors and one that fits perfectly into
Potbelly’s business model. According to research a large percentage of frequent fast casual
diners would make use of rewards programs (See Table 4). Our proposed program would be
strongly supported by Potbelly’s impressive pre existing technology, s o c i a l media platforms
and what appears to be a strong accompanying customer demand for such a program.
Table 4: Survey Results 2013
All
Age
Age
Age
Age
Age
Children
Adults
18-34
35-44
45-54
55-64
65+
under
Use Rewards or special deals
50%
70%
58%
47%
39%
20%
65%
Look up locations or
67%
88%
78%
63%
60%
31%
80%
directions on a smart phone
Source: restaurant.org
Our proposed customer loyalty program, Potbelly Gold, is an automatic rewards program
focused on customer engagement and data generation. Additionally, it is structured to easily
facilitate any future decisions to expand the program or combine with a partnership program. At
the very least the program will be able be able to collect data to generate three key metrics for
data analysis-loyalty program engagement, customer retention ratio, marketing efficiency ratio.
We believe these metrics are important to Potbelly’s strategy and operations.
24 The importance of a customer loyalty program to Potbelly cannot be understated. Marketing
analysts estimate that repeated customers could generate between 5 to 15 times revenue for the
business than first time or one-time buyers alone13. It is important to understand that for
customers it is often a challenge to find a restaurant they trust and once a first time customer has
a positive experience they are willing to come back for more. Popular loyalty programs, such as
point systems, complimentary items, invitation-only events, partnerships with other companies to
provide diverse offers and many others, have been shown to lead to successful retention of
customers. There is ample evidence that not all customers are equal – loyal customers are far
more profitable. Research has demonstrated the powerful economic benefits of increasing
customer retention across multiple industries, product and service companies. Concentrating
management’s attention on attracting and maintaining loyal customers is crucial for businesses to
succeed in today’s competitive world. Even small changes in customer retention rates and
spending levels of loyal customers can have a very big impact on companies’ bottom lines. Also,
transforming customers into staunch “undying” fans of your business – referring others to
become loyal customers too – can turbo-charge profitability as well. In summary the primary
economic benefits of Potbelly Gold include:
•
Reducing customer loss to maintain profit base
•
Increasing the amount spent by loyal customers over time
•
Increasing profits as customer service costs decrease
•
Increase profits as rewards programs induce customers to purchase higher margin menu
items
•
Increase profits through referrals
Under Potbelly Gold, customers will earn points for each dollar spent. When a defined threshold
is met, the points are converted into a reward. After earning the reward, the point values are reset
to zero and customers will begin to earn points toward their next reward. Potbelly customers will
earn rewards based on registration in the program and purchases within Potbelly stores. An
important aspect of this program would be the limited validity period of Potbelly Gold points.
We recommend that fully earned Potbelly rewards should generally expire if unredeemed after
60 days. Partially earned awards should generally expire if inactive for a period of one year.
13 Customerloyaltyprogram.com
25 Rewards should be designed to surprise and delight customers through a combination of product
or item rewards and unique experiences that only Potbelly can provide. After taking a look at
Potbelly’s product line we believe the Potbelly signature cookie and hot pepper jars combined
with great menu discounts are ideal reward items. Alternatively, under our recommended
program, Potbelly can choose to offer guests unrestricted freedom to spend reward dollars
however this should allow for the redemption of low margin items in order to keep costs down.
In addition to rewarding customers for purchases, the program should also reward customers for
recommendations.
In the spirit of Potbelly’s commitment to community service, DangerZone proposes a tweak to
the traditional rewards program. Included in Potbelly Gold is an option to donate rewards to
community charities. Customers would be given the option once they reach a certain number of
points to donate those rewards to a local charity. Alternatively rewards could be given towards
sandwich donations for local food banks. These can be combined with a commitment by Potbelly
to match donations and can be structured around Potbelly’s own charitable giving activities.
This would be a great way to emphasize Potbelly’s brand image and distinguish them from
competitors.
In creating this loyalty program, we find it very important for Potbelly Gold to generate data and
track benefits and efficiency. This might be challenging especially if the Potbelly decides to add
other layers to our proposed basic rewards system. However, at the core of any loyalty strategy,
Potbelly would need to ensure that it keeps track of the benefits and efficiency of its program. As
part of our recommendation we would advise that Potbelly’ program, at the least, keeps track of
three metric that we believe are essential to its business model
Loyalty Program Engagement:
This metric allows Potbelly to measure and understand how many customers are actually
using the Potbelly Gold program. This could be achieved via integrated analytical
systems.
Customer retention ratio:
26 This metric will give Potbelly access to overall customer loyalty views. The importance
of this metric would be in the relative comparison: ratio of customer retention before, and
after introduction of the new loyalty program.
Marketing efficiency ratio:
This allows Potbelly to measure the volume of new customers coming through the
promotional effort of existing customers. This ratio is likely to go up when Potbelly
offers high quality products combines with strong elements of engagement as well as
rewards.
In rolling out Potbelly Gold, our recommended strategy is to begin with a pilot in select Potbelly
stores. This would enable Potbelly to gauge interest and address any problems that might arise
before making it available to stores nationwide. Any plans for marketing should emphasis the
value and experience that Potbelly Gold provides as well the unique opportunity for customers to
donate their rewards to great community development programs.
Continued Focus on Strategic Expansion
Potbelly is currently operating in diverse markets in 21 states and the District of Columbia.
DangerZone recommends that Potbelly focus its attention on building company-operated shops
and franchised businesses in both new and existing markets by utilizing a strategic site selection
process that works for their business model. An analysis of Potbelly’s most successful locations
shows that the brand, known predominantly as a good lunch option tends to do very well in
neighborhoods with very high daytime population, site visibility, traffic and accessibility. This
location-specific approach to development would allow Potbelly to leverage its versatile shop
format, which does not have standardized requirements with respect to size, shape or location, to
achieve strong returns across a wide range of real estate settings. In 2011, 2012 and 2013,
Potbelly opened 21, 31 and 34 new company-operated shops, respectively, and expanded into
New York, Seattle, Boston, Phoenix, Cleveland, Kansas City, Portland, Oregon and Hartford,
Connecticut. In those same time periods, Potbelly closed five shops, one shop and two shops,
respectively, due to underperformance or lease expirations.
27 Their growth strategy includes plans to open new "hub" markets every year-and-a-half or two
years. The rationale is that these areas would give the business a way to reach further into new
regions using "spoke" markets that extend from the hub. Additionally, Potbelly seems to be
expanding its franchising unit with the aim of attracting additional expansion capital and also
expanding within the Middle East. DangerZone sees some potential problems with these growth
trajectories and would recommend an evaluation of Potbelly’s hub and spoke strategy with
expansion to Florida, a commitment to decrease its very high initial investment for franchisers
and halted international expansion to enable maturity in Middle Eastern Markets.
•
Domestic Expansion
Potbelly, since its creation, has been known as the Midwest sandwich chain. This is
however changing as Potbelly looks to expand westward. DangerZone recommends that
Potbelly pair its westward expansion with even more expansion in the east. Familiar
markets and a tried and tested business model might lead to quicker and higher returns
for the sandwich chain. Based on the target demographics we recommend that Potbelly
make a strategic move Orlando, Florida with a long-term goal of further expanding
within those regions and eventually to Georgia if an opportunity presents itself.
Table 5: Breakdown of Potbelly Operations by State
Location
Number of shops
Location
Number of shops
Illinois
87
Massachusetts
87
Texas
43
Washington
43
District of Columbia
21
Oregon
21
Maryland
19
Indiana
19
Michigan
19
Pennsylvania
19
Virginia
17
New Jersey
17
New York
16
Connecticut
16
Minnesota
15
Kansas
15
Ohio
14
Kentucky
14
Wisconsin
9
Missouri
9
Arizona
6
Tennessee
1
28 Figure 2
States where Potbelly currently operates
Florida presents a market fueled by health conscious consumers and a bustling tourism
industry. Industry reports show that Florida’s restaurants particularly in Orlando are
expected to be very busy this year and even busier in the future. Sales are projected to
reach $4.6 Billion up from $33.2 billion in 2013 while national numbers have dropped,
going from a per-person yearly average of 195 meals in 2012 to 192 in 2013 (down from
a peak of 215 in 2000). In part, this boom has been attributed to visitors fleeing winter's
grip in Midwest and North West regions Florida's economy in 2014 is leading the nation
in job growth and the overall recovery, despite once being a straggler. In South Florida,
employment is expected to grow 2.3 percent each year and unemployment to moderate to
an average of 5.7 percent. The average annual wage is forecast to grow by 2.9 percent to
$55,200. Expanding to Florida would not only present an opportunity to capture market
share but also help diversify some of Potbelly’s geographical risk without moving too far
away from its comfort zone. The cosmopolitan and tourist nature of Orlando and Florida
29 in general would also contribute to improving Potbelly’s brand recognition globally.
•
International Expansion
Potbelly is not very clear on what its international expansion strategy is. As of December
29, 2013, Potbelly in partnership with Alshaya operated 12 franchised shops in Kuwait,
the United Arab Emirates and Bahrain and has exclusive franchising rights in the Middle
East. This agreement with Alshaya provides that Alshaya may also open shops in Egypt,
Jordan, Lebanon, Oman, Qatar and Saudi Arabia. In the short term DangerZone
recommends that Potbelly limit its international expansion to the Middle East in lieu of
domestic expansion and establishing a strong brand in existing international locations.
The fast casual sandwich model is not one that can be successful replicated in
many international markets and we recommend that thorough research be done in
moving forward with any international expansion strategy.
•
Franchising
While franchising is currently only a small part of the Potbelly story,” DangerZone
believes that a faster pace of franchise growth- 20% of total operations in the next five
years- can provide the company with a profitable revenue stream, as well as an
opportunity to reach additional lower-priority markets more quickly than through
company-operated growth alone. In addition, Dangerzone recommends that Potbelly
strengthen its current franchising program through reduction in required initial investment
and increased financial support by partnering with Franchise America, a small-to- middle
market commercial franchise finance firm specializing in debt and equity placement.
Finally, Potbelly should incorporate multi unit franchising in its franchising program to
cut down on search and sign up costs and take advantage experienced successful
Franchisees,
30 Figure 3: Current states where Potbelly franchising is available.
DangerZone’s recommendation to increase franchise driven growth is based on
what is believed to be the ideal proportion of franchises for financial
performance in the US restaurant industry - between 30 and 46% of total
company operations (Hsu and Jang 2009). Potbelly is currently very well below
that. Franchising would of course need to be exercised with caution, hence our
recommended 20 % target in five years with an evaluation at the end of this period.
With regard to strategy, franchisors perform better financially if they align their
franchise proportion with their financial and marketing strategies (Srinivasn 2006)
and do not use franchising as a strategy to gather resources, as such an approach has
been seen to prevent a proper fit between on the one hand proportion and on the
other hand business format characteristics and geographical dispersion of units.
Potbelly should provide stronger financial assistance and support for potential
franchisees. Potbelly franchisees have traditionally experienced difficulty accessing
the financial and management resources that they need due to high franchising costs
31 and lack of Franchisor support. Financing from banks and other financial institutions
is not always available to franchisees to construct and open new shops and this could
adversely affect the number and rate of new shop openings by franchisees and
future franchise revenues. These are common difficulties for other competitors,
however Potbelly provides nowhere near the support that its competitors provide
their franchisees. Potbelly can take a similar approach by partnering with a franchise
financer to provide greater financial security for franchisees.
DangerZone would like to recommend Franchise America Finance, a well know
franchise financer, to provide financing for new franchisees and existing
franchisees that want to renovate. Our recommendation is based on Franchise
America’s commitment to providing quality service to company’s similar in size to
Potbelly. They have successfully served as financer’s for well-known brands like The
UPS Store, Carls Jr. and Togo’s, a west coast sandwich shop founded in 1971.In the
industry of Franchise financers they have established a strong reputation for a
business model that is flexible to franchise needs of its customers. Under this
partnership, Potbelly would be able to provide its franchisees with the Finance
America promise- fast, reliable and specialized loan service.
Development costs can be drastically cut down through savings in construction,
interior development and furnishing which currently makes up about 50% of the total
franchising development cost. Centralizing the supply of the construction and
furnishing items can do this. Currently, each store’s furnishings are provided by
individual outside suppliers, which tends to push up prices.
Table 6: Table showing Franchising Costs in Select Fast Casual Chains
Franchise Name
Franchise Fee
Royalty
Development Costs
Potbelly
$40,000
7% of gross
$461,000-$761,000
Subway
$15,000
8% of gross
$85,000-$315,000
Quiznos
$25,000
7% of gross
$24,000-$241,000
Jimmy Johns
$20,000
6% of gross
$194,600- $416,900
32 DangerZone recommends that Potbelly consolidate its supply chain by signing longerterm contracts that would bring in cost savings through discounts. This would reduce the
number of single item purchases done during the construction process and drastically cut
down on costs.
As of now, Potbelly’s franchise model within the United States is mainly based on a
single unit model. Interests to include a multi unit franchise system have been expressed
by Potbelly management and DangerZone would recommend that Potbelly go through
with implementing a multi-unit franchise system for locations with more than one
Potbelly alongside its single unit model. This would benefit Potbelly because it can grow
more easily through the re-use of existing franchisees. Moreover, multi-unit franchisees
make the system more effective by facilitating efficient system-wide adaptation because
franchisors have to persuade fewer franchisees to implement changes. Additionally,
Potbelly currently has a very strong selection process that can reduce the risk of ending
up with an incompetent franchisee.
33